The note says that Japanese banks are looking for yield elsewhere not just in other safe haven government bonds but also corporates.

It says: “As the Japanese central bank prioritises the buy-back of longer term bonds, the interest rate curve should further flatten. Interest rates should remain low for all maturities. The low interest rate environment is forcing investors to search for yields internationally. Purchases of German Bunds and French government bonds by Japanese banks could be observed as far back as 2012. The movement towards higher yielding foreign government bonds is likely to continue this year. Peripheral Europe‘s government bonds are registering higher demand as well while the yen is likely to remain under pressure due to capital outflows. Further attractive investment destinations: AAA-rates government bonds outside the G4 such as Australia, New Zealand and Canada.”

In terms of the European Central Bank, the CIOs note that the ECB is getting very concerned about credit differentials within the eurozone which are being determined in part by the location of the borrower. The note says: “The distorted transmission mechanism is continuing to restrict growth. As early as December 2012, ECB Executive Board member, Joerg Asmussen, said that the interest rate for loans in the eurozone is determined not only by the solvency, but also to a considerable extent by the residence of the borrower. It now seems to be only a matter of time until the ECB dares to make a further advance against the fragmentation of the credit market.

“The ECB is still aiming to bring down the interest rate spreads between the peripheral and the core countries in the eurozone. So carry and tightening remains an attractive strategy in order to benefit from potential bond price gains in the periphery. The target of the carry flows, however, should not just be government and corporate bonds in the eurozone. Covered bonds from the periphery also offer appealing yields that exceed the European rate of inflation.”

The note suggests that investors, rather than accept negative real interest rates, will have to accept a greater risk to achieve a real positive return.

“The trend to shift from safe government bonds in the direction of sovereign peripheral bonds, corporate bonds from Europe and emerging countries and high yield bonds is likely to continue. The reason is quite clear. Safe government bonds only offer negative real rates. Investors must therefore accept greater risk in order to achieve a positive real return. Ultimately, they will have to endure some turbulence, not least because investors are increasingly switching to corporates from Europe and the emerging markets. the European discussion is here to stay and is set to provide further cause for volatility.”